When I am comparing ETFs like VXUS (Vanguard Total International Stock ETF), VBR (Vanguard Small-Cap Value ETF), and VWO (Vanguard MSCI Emerging Markets ETF), is the following method correct, in determining which one is best/worst to put in a taxable account or a Roth IRA account?

Second, I find out the 12-month yield of the ETF (available on the "Fees & Expenses" tab on the Morningstar quotes for the ETFs), and I find out an estimate of the percentage of the yield that is distributed as qualified dividends (available for Vanguard ETFs, here).

Once I know the yield and the percentage of qualified dividends that each ETF distributes, I can calculate how much of a tax liability each ETF generates. For instance, here is the yield and percentage of distributions that are qualified dividends for VXUS, VBR, and VWO:

VXUS will generate $289 in annual dividends, and 68% of that amount will be qualified and taxed at 15% (for me) and 32% of it will be ordinary and will be taxed at 25% (for me), resulting in $45 dollars of taxes each year.

VBR will generate $246 in annual dividends, and 78% of that amount will be qualified and taxed at 15% (for me) and 22% of it will be ordinary and will be taxed at 25% (for me), resulting in $42 dollars of taxes each year.

VWO will generate $219 in annual dividends, and 57% of that amount will be qualified and taxed at 15% (for me) and 43% of it will be ordinary and will be taxed at 25% (for me), also resulting in $42 dollars of taxes each year.

Thus, I can conclude that it would be slightly more tax efficient to hold $10,000 of VBR or VWO in a taxable account and $10,000 of VXUS in a Roth IRA, keeping in mind that this example assumes that each ETF will grow at the same rate (and, therefore, that the capital gains tax from selling these ETFs can be ignored, since it would be an equal amount for each one--maybe this makes my conclusion invalid, though?) and does not take tax-adjusted asset allocation issues into consideration.

Also...

BrandonBogle wrote:Don't forget that VXUS will give you dividends AFTER foreign taxes paid, which can be tax-deductible, giving a preference for VXUS to be in a taxable account.

grabiner wrote:I usually estimate the foreign tax credit at 7% of the dividend yield.

Last edited by Hastibe on Thu Feb 21, 2013 10:12 pm, edited 2 times in total.

Okay, right, that would also effect things. Thanks for pointing that out! Beyond that also not being taken into consideration in my method above, is my method missing anything else in determining tax liability and thus what to put in taxable/Roth IRA accounts?

In the last few years, foreign dividend yields have been higher than US yields. (The reason you do not see this in your data is that your VBR is a value fund, which has a higher yield than the US stock market; VXUS and VWO are blend funds.) This has not historically been the case; if US yields and foreign yields are equal, that makes foreign funds relatively more attractice in taxable accounts.

I usually estimate the foreign tax credit at 7% of the dividend yield.

And if you are slicing and dicing your international funds, you can reduce the tax cost by using Tax-Managed International (or the ETF class VEA) as your core fund. Tax-Managed International has 100% qualified dividends, compared to about 75% for Developed Markets Index (the non-tax-managed version of the same index). 65% VEA/20% VWO/15% VSS is about equivalent to Total International, and you can change those allocations in order to overweight small-cap or emerging markets.

If you plan to aggressively Tax Loss Harvest then you might need to consider which ETFs/funds you plan to switch to after you sell. There may be good options for VBR (like an extended market fund), but maybe not so much for the other two. Although, there are other ways to TLH instead of switching to a comparable fund.

If you have little or no carryover losses to date, then you might consider investing in all three funds to increase your chances in the near future of some losses.

bdpb wrote:If you plan to aggressively Tax Loss Harvest then you might need to consider which ETFs/funds you plan to switch to after you sell. There may be good options for VBR (like an extended market fund), but maybe not so much for the other two. Although, there are other ways to TLH instead of switching to a comparable fund.

VXUS (Total International) or VEA (Tax-Managed International) can be paired with each other, or with VEU (FTSE All-World Ex-US large-cap).VWO and VSS have no Vanguard partners, but you could use non-Vanguard emerging markets and foreign small-cap indexes, such as EEM (iShares MSCI Small-Cap) for VWO (which tracks the FTSE index), and SCHC (Schwab International Small-Cap) for VSS.

I would not consider EEM and VWO substantially identical now that they track different indexes (with different countries considered emerging), but I cannot give tax advice, and the IRS has never issued a ruling.